Chapter

1. 3 Chapter Financial Analysis

2. Classification System PPT 3-1 We will separate 13 significant ratios into four primary categories. A. Profitability Ratios. 1. Profit margin. 2. Return on assets (investment). 3. Return on equity. B. Asset utilization ratios. 4. Receivable turnover. 5. Average collection period. 6. Inventory turnover. 7. Fixed asset turnover. 8. Total asset turnover. C. Liquidity ratios. 9. Current ratio. 10. Quick ratio. D. Debt utilization ratios. 11. Debt to total assets. 12. Times interest earned. 13. Fixed charge coverage.

3. PPT 3-2

4. $200,000 $4,000,000 Net income sales Net income Total assets $200,000 $1,600,000 Net income Sales Sales Total assets Net income Stockholders’ equity $200,000 $1,000,000 Return on assets (investment) (1 – Debt/Assets) 0.125 1 – 0.375 0.10 1 – 0.33 PPT 3-3 Profitability Ratios Saxton Company Industry Average 1. Profit margin = = 5% 6.7% 2. Return on assets (investment) = a. = 12.5% 10% b. 5%  2.5 = 12.5% 6.7%  1.5 = 10% 3. Return on equity = a. = 20% 15% b. = 20% = 15% 

5. PPT 3-4

6. PPT 3-5

7. Sales (credit) Receivables $4,000,000 $350,000 $350,000 $11,111 Sales Inventory $4,000,000 $370,000 PPT 3-6 Asset Utilization Ratios Saxton Company Industry Average 4. Receivables turnover = = 11.4 10 times 5. Average collection period = = 32 36 days 6. Inventory turnover = = 10.8 7 times Accounts receivable Average daily credit sales

8. Sales Fixed assets $4,000,000 $800,000 Sales Total assets $4,000,000 $1,600,000 PPT 3-6 Asset Utilization Ratios Saxton Company Industry Average 7. Fixed asset turnover = = 5 5.4 times 8. Total asset turnover = = 2.5 1.5 times

9. Total debt Total assets Income before interest and taxes Interest Income before fixed charges and taxes Fixed charges PPT 3-8 Debt Utilization Ratios Saxton Company Industry Average 11. Debt to total asets = = 37.5% 33% 12. Times interest earned = = 11 7 times 13. Fixed charge coverage = = 6 5.5 times $600,000 $1,600,000 $550,000 $50,000 $600,000 $100,000

10. PPT 3-9

11. PPT 3-10

12. PPT 3-11

13. PPT 3-12

14. PPT 3-13

15. Chapter 3 - Outline LT 3-1 • Financial Analysis • 4 Categories of Financial Ratios • Importance of Ratios • Inflation and its Impact on Profits

16. Financial Analysis and Ratios LT 3-2 What is financial analysis? • Evaluating a firm’s financial performance • Analyzing ratios or numerical calculations • Comparing a company to its industry

17. 4 Categories of Ratios LT 3-3 • Profitability Ratios • Asset Utilization Ratios • Liquidity Ratios • Debt Utilization Ratios

18. Profitability Ratios LT 3-4 Show how profitable a company is. The ratios express: — Profit Margin or Return on Sales (%) — Return on Assets or Return on Investment (%) — Return on Equity (%)

19. Asset Utilization Ratios LT 3-5 Show how effectively a company uses its assets. The ratios express: — Receivables Turnover (times) — Average Collection Period (days) — Inventory Turnover (times) — Fixed Asset Turnover (times) — Total Asset Turnover (times)

20. Profitability and Turnover Ratios LT 3-6 Remember: Return on X = Net Income / X X Turnover = Sales / X

21. Liquidity Ratios LT 3-7 Show how liquid a company is or how much $ it has to meet S/T needs. The ratios express: —Current Ratio (times) —Quick Ratio or Acid-Test Ratio (times)

22. Debt Utilization Ratios LT 3-8 Show how well a company is managing or using debt. The ratios express: —Debt-to-Total Assets (%) —Times Interest Earned (times) —Fixed Charge Coverage (times) (Fixed Charges = lease payments, i expense)

23. Importance of Ratios LT 3-9 Which ratio is most important? It depends on your perspective. • Suppliers and banks (lenders) are most interested in liquidity ratios. • Stockholders are most interested in profitability ratios. • A long-run trend analysis over a 5-10 year period is usually performed by an analyst.

24. Inflation’s Impact on Profits LT 3-10 • FIFO (First-In, First-Out) Inventory: —Lowers COGS —Raises Profits • LIFO (Last-In, First-Out) Inventory: —Raises COGS —Lowers Profits